"Workers taking ill health early retirement risk unexpected pensions tax bill – new FOI"

The issue arises because those who are no longer able to work because of ill health can be awarded a significant overnight boost to the value of their pension rights. In some schemes, a worker is treated as if they had continued working from the date of early retirement right up to pension age, and the additional pension rights from that assumed service are added in one lump. The income tax system then treats this as if they had made massive contributions into their pension in a single year. This huge growth in the value of their pension rights can easily exceed the £40,000 annual limit, especially if they are some years away from retirement.

The case study below gives the example of the Greater Manchester Pension Fund which explains the issue in a booklet for members and which provided data in an FOI to Royal London.

Commenting, Steve Webb, Director of Policy at Royal London said:

“Pension schemes do not hand out early retirement benefits lightly, and it seems very harsh to punish those who are in poor health with big tax bills. It is not the case that the workers who face these bills have been shovelling money into a pension in order to max out on pension tax relief. They have simply found themselves unable to do their job, often through no fault of their own, and it is quite wrong to saddle them with a large tax bill as a result”.

Case study: The Greater Manchester Pension Fund

The Greater Manchester Pension Fund (GMPF) publishes a guide to members on ill health early retirement (see https://www.gmpf.org.uk/documents/illhealth.pdf). The guide explains the different tiers of ill health early retirement benefits which are available. For workers who qualify for the more generous enhancements (known as ‘tier 1’ and ‘tier 2’ benefits – defined on p14 of the booklet), the guide says:

“If you retire on ill health under tiers 1 or 2 you may be subject to an annual allowance test unless the approved doctor certifies that you are suffering from ill health which makes it unlikely that you will be able ….to carry out gainful work (in any capacity) before reaching your State pension age. This is known as the severe ill health criteria. If the approved doctor certifies that you do not meet the severe ill health criteria, then you will be subject to the annual allowance test and we will work out the growth in your pension savings in the year you retire and compare this to the annual allowance limit. Note: an ill health enhancement may cause a significant growth in the value of your pension savings in the year you retire. If this causes you to exceed the limit, we will write to you with more details at that time”. (See p16)

In simple terms, for those who are ill enough to qualify for ill health early retirement, but not so severely ill that they will never work again in any capacity, the growth in their pension will be tested against the annual allowance.

An FOI to Greater Manchester Pension Fund from Steve Webb, Director of Policy at Royal London showed that in 2018/19 ten members of the scheme received letters to say that their pension growth had taken them above the annual allowance, and six of these were subject to a tax charge. If this rate is typical across all public sector pension schemes, this suggests that hundreds of workers taking ill health early retirement are facing tax charges of this sort each year.